This is a question I often get asked in practice and the answer is, almost invariably, yes.
What is a participation agreement?
A collective freehold purchase involves a commitment from all of the participants to act together in the purchase of the freehold. The participation agreement sets out the legal relationship between those taking part.
Normally there will be a company (called a ‘nominee purchaser’) incorporated by the flat owners to hold the freehold after completion. The agreement sets out the legal relationship between the proposed participants and the company.
What sort of things does it cover?
There are no hard and fast rules and it is possible to customise the agreement to suit the particular features of your transaction. If you are thinking of buying your freehold you should establish the ‘key terms’ agreed between those taking part as soon as possible and then formalise these in a written agreement.
A good agreement will cover include the answers to the following quesitons which are set out under the headings below:-
What are the financial obligations of each flat owner taking part?
How much will each individual flat owner taking part will have to pay towards their own share of the purchase price?
This depends on a number of factors, not least how many flats take part and also whether the price is to be divided equally between all those taking part. Who is going to decide on how this is done? Will there be fixed proportions or will someone (e.g. the valuer) have the power to decide?
Are larger flats (or more valuable ones) going to be asked to pay more? If so, how will this be calculated. By reference to flat size and/or value, or by some other means?
How are the transactional costs of the process (legal and valuation fees for the freeholder and the flat owners) going to be allocated?
Are these to be split equally (the simplest mechanism but not necessarily the fairest), or will some other basis (e.g. flat value) be used?
What happens if people want to pull out?
It may be a good idea to ensure that there is some sort of cut off point in terms of time, price or numbers that might trigger the possibility of the process being abandoned if the capital cost of buying the freehold appears to be too high.
Who is going to pay for the costs of those not taking part?
Are these costs to be split equally or will some other mechanism be applied? – e.g. will one or more of those taking part pay in more money and get something in return. Or will everyone’s contribution be increased and then any future income shared out?
What do I get in return for my money?
The agreement may also cover things that will happen after the freehold has been purchased – e.g. the issue of a share in the company and also the right to extend the lease on your flat to 999 years.
What about outside funding?
Is the company going to obtain funding from outside sources? – for instance an individual investor, or a bank mortgage (which is sometimes possible if the ground rent income is high enough). If there is an outside investor, what will be the basis of their return? Will they obtain head leases over some of the flats, or have the benefit of another area of value in the property?
There may be more than one class of share in the company (one for investors and one for those taking part) with different rights. The funds subscribed may be documented in a loan agreement to make dealing with future income more straightforward.
So, remind me again, why do I need an agreement?
As well as the points above, serving a notice has consequences in cost terms both for the flat owners and for the landlord.
If the flat owners pull out of the process having served a notice they will become liable for the landlord’s legal and valuation costs. Clearly it is better to have all those who commit to the process signed up to a binding agreement so that there is a clear understanding that if they pull out they will have to pay their way.